Boat Ltd. has a proposal for manufacturing Mechanised Boats. The project would involve cost of plant at ₹ 750 lakh, installation cost of ₹ 150 lakh and working capital of ₹ 175 lakh. The annual capacity of the plant is t

CS Professional · Financial, Treasury and Forex Management · PYQS · December 2018
Boat Ltd. has a proposal for manufacturing Mechanised Boats. The project would involve cost of plant at ₹ 750 lakh, installation cost of ₹ 150 lakh and working capital of ₹ 175 lakh. The annual capacity of the plant is to manufacture 30,000 Boats. Price per Boat is ₹ 30,000, with a variable cost ratio of 70%. Cash-fixed cost in the first year, including promotion expenditure of ₹ 180 lakh, is ₹ 630 lakh and is thereafter ₹ 450 lakh each year. The company expects that the plant's capacity utilization over its estimated useful life of five years is as under: Year 1 2 3 4 5 Capacity utilization % 25 40 50 75 100 Terminal value of the project is ₹ 95 lakh. If the hurdle rate is 12%, and tax rate is 30%, can the project be accepted? While evaluating, you have to keep in mind that the company has other sources of income against which the losses, if any, from this project can be set off. Project implementation cost to be considered on year 0, and cash flow to start from year I. Consider PVF rate upto three decimal points.

Answer & Explanation:

Initial outflow (Year 0) Capital expenditure ₹ in lakh ₹ in lakh Cost of plant 750 Installation cost 150 Total Fixed Assets 900 Working capital 175 Total Initial Outflow 1075 Annual depreciation = (Cost of plant + Installation cost - Terminal value) / Useful life = (₹ 900 lakh - ₹ 95 lakh) / 5 years = ₹ 805 lakh / 5 = ₹ 161 lakh Calculation of Cash flow after tax (CFAT) Particulars Year 1 Year 2 Year 3 Year 4 Year 5 Capacity utilization % 25 40 50 75 100 Volume units (30,000 * %) 7,500 12,000 15,000 22,500 30,000 Sales (₹ 30,000 * units) 2,250 3,600 4,500 6,750 9,000 Contribution @ 30% (Sales * 30%) 675 1,080 1,350 2,025 2,700 Fixed cost (₹ in lakh) (630) (450) (450) (450) (450) Depreciation (₹ in lakh) (161) (161) (161) (161) (161) PBT (₹ in lakh) (116) 469 739 1,414 2,089 Tax @ 30% (₹ in lakh) Nil (Loss set off) (106)* (222) (424) (627) Profit after Tax (PAT) (₹ in lakh) (116) 363 517 990 1,462 CFAT (PAT + Dep) (₹ in lakh) 45 524 678 1,151 1,623 * Calculation of PAT for 2nd year: PBT of 2nd year: ₹ 469 lakh Less: Loss c/f from Year 1: ₹ 116 lakh Taxable profit: ₹ 353 lakh Tax @ 30%: ₹ 106 lakh PAT of 2nd year = ₹ 469 lakh - ₹ 106 lakh = ₹ 363 lakh Calculation of Net present value (NPV) Year CFAT in ₹ Lakh PVF @ 12% PV in ₹ Lakh 0 (1075) 1.000 (1075.000) 1 45 0.893 40.185 2 524 0.797 417.628 3 678 0.712 482.736 4 1151 0.636 732.036 5 (CFAT + Terminal Value + Working Capital Recovery) 1623 + 95 + 175 = 1893 0.567 1073.451 NPV 1670.916 Decision: Since, NPV of the project is positive (₹ 1670.916 lakh), it should be accepted.

Topics: Capital Budgeting

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